Expert Q&A: Plotting a Rewards Card Hit and Run
By Eva Norlyk Smith, Ph.D.
September 16, 2011
Editor’s Note: CreditCardGuide.com is excited to announce our newest column “Credit Smarts” by longtime correspondent Eva Norlyk Smith. Eva specializes in helping consumers make the most of credit card offers — and avoid the traps. Got a question? Ask Eva!
I received an offer in the mail for a rewards credit card that offers 50,000 bonus points in the first three months if I spend $3,000. However, the annual fee is $100 a year after the first year, and I don’t want to pay that. Would it be a good strategy to apply for the card, then close it after a year? I heard that some people do that all the time. I already have one cash-back credit card that I’ve used for about three years. It doesn’t have an annual fee, but the cash-back amounts aren’t that high either. I like the idea of applying for cards with sweet sign-up offers and then canceling them before I have to pay anything. But how would that affect my credit? — Clark
Welcome to the complex world of credit scores and credit card management. Your question is a good one. At this very moment, I’m sure that thousands of people all over the country are looking at lucrative credit card bonus offers and asking themselves the same thing.
There are two answers to your question: A simple answer and a more complex one. You’ll like the simple answer: It’s true that each time you apply for credit, it could lower your credit score — but not by very much.
When you apply for new credit, the lender pulls your credit file, and too many credit inquiries will pull down your score. The impact from applying for credit varies from person to person. However, for most people, an occasional credit inquiry will shave less than five points off the score, according to FICO.
The effect lessens after six months and disappears after 12 months (unless you apply for other lines of credit in the meantime). So if you haven’t applied for other types of credit in a while, applying for a new credit card won’t affect your score that much.
Unfortunately, that’s just the sweet and simple answer to your question. And, like most simple answers, it does not give you the complete picture. The more complex answer to your question is: It depends.
It depends on your current credit history, how many credit cards you already have, your future plans and, quite frankly, how much time you have on your hands to manage your credit cards and potential bonus earnings.
First of all, just because you get a credit card offer in the mail doesn’t mean that it’s the right card offer for you. For example, the offer you are mentioning requires you to charge $3,000 in three months. If you usually charge $1,000 or more on your credit card each month, that probably won’t be much of a challenge.
However, if you rarely charge that much, chances are that you’ll be tempted to do what so many people before you have done: You’ll spend more than you can afford just to get the 50,000 bonus points. It’s a trap that’s easy to fall into, and most of us don’t even realize we’re vulnerable. Yet, studies show that many people do spend more when given a rewards card.
If you’re thinking about your credit score, you also need to think about the long-term impact to your credit file. If you’re trying to build or maintain your credit score, then doing a promotional hit and run is probably not in your best interest.
That’s because getting seduced by great bonus offers from credit cards you don’t really want to hold on to is exactly the opposite of what you should be doing to boost your score. Instead of jumping from card to card, you are better off building up a solid portfolio of credit cards that you’ve had for a long time.
Holding on to credit cards for a long period of time helps you build a long-term credit history that shows you’re a trustworthy borrower. In addition, keeping many lines of credit open with low or zero balances will boost your credit utilization score, which is a measure of how much of your available credit you are using. Together, these two features make up 45 percent of FICO scores, and each time you cancel a credit card, it will affect these components of the score. For the best credit scores, most experts advise that you hold on to three to four credit cards and use them regularly.
So the good news for you is that, yes, it’s probably a good idea for you to add one or two more credit cards to your portfolio, especially if you only have one card. (If you will be applying for a mortgage within the next few months, however, you’re better off waiting until after you’ve applied.)
The even better news is that you can have your cake and eat it, too. Instead of going with the first offer that lands in your mailbox, do a little digging around. There are many credit card offers online that come with great cash-back earnings, don’t charge an annual fee and, yes, offer great sign-up bonuses as well.
Look for one or two cards that you think you will find useful over the long-term, and if they come with great bonus offers as well, then, hey, that’s even better!